Sensible Student Loan Solutions in the Budget Agreement
Blog Post
Dec. 11, 2013
See this post here for more on Ed Central's take on the overall budget agreement.
Last night, the chairs of the House and Senate Budget Committees released a bipartisan budget conference agreement. Though the agreement still must be voted on to become law, it’s an important step toward resolving budget disagreements for the next two years and identifying specific areas for cuts and offsets.
Student aid has been a part of just about every budget deal in the past few years, and it's been on net pretty good for students, because even though some programs were sacrificed, the Pell Grant has maintained a high maximum award. This bill does not have any specific provisions dealing with Pell, but if it becomes law it would make two important changes to the federal student loan program, one that will lighten the burden a bit for struggling borrowers and the other that would rectify an unnecessary political giveaway under an earlier budget deal. Both are examples of the few remaining policy win-win opportunities where federal money that now flows to student loan businesses can be better spent, including some on students. From a policy perspective, these changes are fixing errors that made no sense in the first place.
Rehabilitation Help
Borrowers who default on their federal loans have an opportunity to get them back into good standing through a process known as loan rehabilitation. To rehabilitate a loan, the borrower works out a set of reasonable and affordable monthly payments with the current holder of their loan. Once a borrower makes nine on-time payments at the agreed-upon amount in a 10-month period, the loan can return to current status and the default notation goes away on credit reports.
Loan rehabilitation in the now-defunct bank-based system known as the Federal Family Education Loan (FFEL) Program is handled by what’s known as a guaranty agency. These are either nonprofit or quasi-public agencies that act as middlemen in the FFEL Program by using federal dollars to repay lenders for defaulted loans and then collecting on the debts for the Department, keeping a massive share of the funds in the process.
When a guaranty agency rehabilitates a loan, it either sells it to another company or assigns it to the U.S. Department of Education if it cannot find a buyer. Once it does so, the guaranty agency is legally allowed to choose whether to charge collection costs to borrowers, which are capitalized and added to the principal balance owed. These fees are not connected to actual expenses incurred by the guaranty agency, but they are capped in law at no more than 18.5 percent of the FFEL loan balance—more than what a similar borrower would be charged if they rehabilitated a Direct Loan, according to the Department’s budget documents.
But collection costs comprise only about half of the money a guaranty agency rakes in from a loan rehabilitation. The other half comes from taxpayers. Guaranty agencies retain as payment another 18.5 percent of the loan balance on top of the collection costs. That’s money that the federal government will never get back from the borrower. It’s a giveaway of roughly 37 percent of the loan balance just to get borrowers to make nine small payments on time.
The budget agreement ends this unnecessary double compensation and takes a small sting out of the collection fees for borrowers too—both changes the Department had called for in its fiscal year 2014 budget. Under the proposed agreement, guaranty agencies would keep only the collection fees, which would be reduced to 16 percent instead of 18.5 percent. That other 18.5 percent they used to retain would go back to the government, where it should have been the whole time. This would rationalize guaranty agency compensation so they get paid only for the collection work, not random other bonuses written into law. Those tweaks alone save over $2.5 billion. Unfortunately, we cannot estimate the savings per guaranty agency because the Department does not provide public data on loan rehabilitation amounts.
The reduction in collection costs, while modest, is a benefit for borrowers. In the case of the average borrower in default, who owes $14,500, that 2.5 percentage point reduction in collection costs saves him over $360. That’s money that won’t have to be paid back with interest and would presumably give them a small break on their monthly payments. And it saves the taxpayers money, as well.
In short, it’s a modest benefit to borrowers for whom every bit helps; it eliminates an unnecessary disparity based upon the type of loan program; and it generates taxpayer savings from a set of agencies that no longer has a useful purpose in the program anyway. In a world where cuts to basic social support programs are frequently on the table, this is a painless choice.
Ending the Nonprofit Servicer Giveaway
The other major student aid change in the budget agreement is to end the special treatment of nonprofit loan servicers. When Congress voted to end the FFEL Program in 2010, the vast majority of Direct Loan servicing switched to a competitive bidding structure in which four companies won the rights to service loans. But a certain set of smaller, but politically connected, agencies persuaded Congress to guarantee them at least 100,000 borrower accounts each through a no-bid process. Even better, they would be paid more per student on those 100,000 accounts than the competitively chosen companies while providing the same required services. And to fund this, Congress diverted some of the money saved from ending FFEL away from the Pell Grant and into a special fund for these entities. And those funds would be provided as an entitlement to those agencies.
As we detailed in September, borrowers have not been particularly pleased with the quality of these nonprofit entities, giving them customer satisfaction scores below those of even Sallie Mae. And it’s not clear whether the extra money spent on the nonprofit servicers is buying better results for students. In response to that post, representatives of nonprofit servicers disagreed, stating that they believed the entities are providing better results for students. New America asked three times for information to verify that argument, but has yet to receive anything in response.
The budget agreement would end this giveaway, striking not just the money set aside to pay for these servicers, but also eliminating the language guaranteeing them 100,000 accounts apiece. This is a welcome change that New America has argued for the in the past. It’s important to have some diversity of servicers in the program to keep them competing, but spending more money on smaller, less efficient entities just did not make any sense. This change would ensure that the people helping students navigate repayment are doing so based upon their competitive merits, not longstanding political connections and effective lobbying campaigns. It saves about $3 billion in mandatory money, though the overall savings are a bit less because some servicing costs will move to the discretionary side of the budget.